Question

You are financial managers of a company which makes printers. Currently you are using NPV method to evaluate a 10-year project that produces a new model.

The WACC is 10% and the tax rate is 21%. (2 points)

1. The project needs a set of machine that is worth $5 million. The company uses 10-year straight-line depreciation.
2. In the past two years, the company spent $800,000 in R&D in developing the new model.
3. The project will be partially financed with debt, and the interest to be paid every year is $100,000.
4. If the new project is taken, it is expected that the current inventory level will increase by $1,500,000, account receivable will increase by $1 million, account payable increases by $800,000, and the minimum cash balance will increase by $0.5 million.
5. The sales from this project will be $8 million per year of which 20 percent will be from lost sales of existing products.
6. The variable costs of the production will be 30% of the sales.
7. The project will require hiring a new manager, who will cost $100,000 per year. In addition, the firm needs to rent a new office for $50,000 a year.
8. Currently, the overhead of the firm is $500,000. And the accounting department will allocate 20% of it to the new project.

Question 1: How much is the initial investment at t=0?

Question 2: How much is the operating cash flow for the first year?

Question 3: How much is the non-operating cash flow at the end of the last year?

Question 4: How much is the NPV?

Answer 1

1. Increase in Net working capital = Increase in Inventory+ Increase in Receivables - Increase in payables + Increase in Minimum cash balance

=$1.5 million + $1 million -$0.8 million +$0.5 million

= $2.2 million

This will be recovered at the end of the project period i.e. at the end of 10 years

Initial Investment (at t=0)= Machine cost + Increase in Networking capital

=$5 million + $2.2 million =$7.2 million

2. Operating cash flows at the end of 1st year (and also each year from years 1-10)

Sales =80% of $8 million = $6.4 million

Variable cost = 30% of $6.4 million = $1.92 million

Fixed costs = $100000 + $50000+ 20% of $500000 = $0.25 milion

Depreciation = $5 million/10 = $0.5 million

Interest = $0.1 million

Profit before tax = $3.63 million

Tax (21%) = $0.7623 million

Profit after tax = $2.8677 million

Cashflows(After adding depreciation) = $3.3677 million

3. Non operating cashflow = recovery of Net working capital = $2.2 million

4. NPV (in million $) = -7.2 +3.3677/1.1+ 3.3677/1.1^2+...+3.3677/1.1^10 + 2.2/1.1^10

= -7.2+ 3.3677/0.1*(1-1/1.1^10)+2.2/1.1^10

=$14.34125388 million

or   $14,341,253.88